I write about the Supreme Court, the intersection between the legal and business worlds, and occasionally about politics. I graduated from the University of Michigan Business and Law schools and the Columbia University Graduate School of Journalism. I started my career at Hughes Hubbard & Reed, a corporate law firm. After switching to journalism, I covered the corporate scandals at WorldCom and Adelphia, Eliot Spitzer, the SEC, and the Supreme Court as a reporter for the New York Law Journal. I have also written for American Lawyer Magazine and Legal Affairs Magazine, and authored Children of Armenia: A Forgotten Genocide and the Century-Long Struggle for Justice (Simon & Schuster). Feel free to subscribe to me on Facebook or follow me on Twitter: @mbobelian.

Court Dismisses Challenge To Fed's Bailout Of AIG

As the economy spiraled downward in 2008, the government faced a stark decision. Should it allow more of the world’s leading financial institutions to follow Lehman’s path to destruction? Or should it come to their aid to avoid a global economic meltdown?

Both President George W. Bush and his successor, Barack Obama, responded with bailouts to stem the crisis.

Through the Troubled Asset Relief Program (TARP), the U.S. government made $700 billion available to purchase toxic assets – primarily troubled mortgages – from the nation’s leading banks, including Bank of America, Citigroup, Wells Fargo, and Morgan Stanley. General Motors and Chrysler also received $80 billion in assistance, making them the largest beneficiaries of the program outside of the financial sector.

There was plenty of debate at the time whether these failing institutions deserved a taxpayer-funded lifeline. At the insistence of Senator John McCain, the presidential candidates temporarily suspended their campaigns to join in high-level talks in the nation’s capital while Congress deliberated the terms of the bailout. Mitt Romney, months removed from his first presidential bid, also chimed in, arguing against the auto bailout while supporting increased government research in the auto sector.

There are still spats over whether the government extracted enough reforms – and promises to help consumers – from these companies when it came to their aid.

What has received little attention, however, has been the legality of these measures.

One notable voice has been the exception to this silence. AIG’s former chairman and CEO, Maurice Greenberg, has criticized the largest of these bailouts involving the company he helped grow into a giant.

By insuring many of the mortgage-backed securities that turned toxic in late 2008, AIG faced insurmountable odds. Through a combination of government stock purchases and loans, it received $182 billion from the U.S. Treasury and the Federal Reserve Bank. Without the government’s help, it was bound to fail.

In return for the billions injected into the struggling insurer, the government made hefty demands, however. The New York branch of the Federal Reserve Bank obtained almost 80 percent of the voting power in the company, demanded an interest rate of 14.5 percent for its loans, and eyed AIG’s assets as collateral.

The bailout was an extraordinary use of government power and the terms it imposed were harsh.

A lawsuit filed last year in a federal court in Manhattan by Starr International, a large AIG shareholder Greenberg currently heads, characterized the Fed’s actions during the financial crisis as a breach of its duties to AIG’s shareholders.

According to Starr, the Fed blocked AIG from renegotiating the contracts with its counterparties, which would have improved the company’s bottom-line. Instead, much of the original funds transferred from the Fed to AIG went to the banks tied into contracts with the insurer, with more than $10 billion a piece funneled directly to Goldman Sachs, Societe Generale, and Deutsche Bank. For the most part, these banks were made whole on AIG’s obligations without being forced to take discounts.

At the heart of the case, Starr questioned the fairness of the terms imposed by AIG compared to these other banks.

In an 89-page opinion, Federal District Judge Paul A. Engelmayer dismissed the claims through a point-by-point assessment of the arguments and counter-arguments put before the court.

On a broader, symbolic level, however, the ruling granted legal legitimacy to the government’s bailout.

In some way, this case reminded me of President Harry Truman’s 1952 seizure of the nation’s steel industry. Just as in 2008, the nation was in the middle of a crisis – the Korean War. When talks between the leading steel manufacturers and unions broke down, threatening to disrupt steel production, Truman intervened in order to maintain a steady supply of steel for the war effort.

Ultimately, the Supreme Court rejected the seizure as an unconstitutional exercise of presidential power. The big difference in AIG’s case was that the company entered into an agreement with the Fed – albeit under dire circumstances. “Merely because the AIG Board felt it had ‘no choice’ but to accept bitter terms from its sole available rescuer,” Judge Engelmayer concluded, “does not mean” that the Fed owed any fiduciary duties towards AIG’s shareholders.

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